| Some
basic key investing concepts: |
Source: SEC |
Savings
Your "savings" are usually put into the safest places or products that
allow you access to your money at any time. Examples include savings
accounts, checking accounts, and certificates of deposit. At some banks
and savings and loan associations your deposits may be insured by the
Federal Deposit Insurance Corporation (FDIC). But there's a tradeoff for
security and ready availability. Your money is paid a low wage as it works
for you.
Most smart investors put enough money in a savings product to cover an
emergency, like sudden unemployment. Some make sure they have up to 6
months of their income in savings so that they know it will absolutely be
there for them when they need it.
But how "safe" is a savings
account if you leave all your
money there for a long time, and the interest it earns doesn't keep up
with inflation? Let's say you save a dollar when it can buy a loaf of
bread. But years later when you withdraw that dollar plus the interest you
earned, it might only be able to buy half a loaf. That is why many people
put some of their money in savings, but look to investing so they can earn
more over long periods of time, say three years or longer. |
Investing
When you "invest," you have a greater
chance of losing your money than when you "save." Unlike FDIC-insured
deposits, the money you invest in securities, mutual funds, and other
similar investments are not federally insured. You could lose your
"principal," which is the amount you've invested. That's true even if you
purchase your investments through a bank. But when you invest, you also
have the opportunity to earn more money than when you save.
But what about risk? All investments involve taking on risk. It's
important that you go into any investment in stocks, bonds or mutual funds
with a full understanding that you could lose some or all of your money in
any one investment. While over the long term the stock market has
historically provided around 10% annual returns (closer to 6% or 7% "real"
returns when you subtract for the effects of inflation), the long term
does sometimes take a rather long, long time to play out. Those who
invested all of their money in the stock market at its peak in 1929
(before the stock market crash) would wait over 20 years to see the stock
market return to the same level. However, those that kept adding money to
the market throughout that time would have done very well for themselves,
as the lower cost of stocks in the 1930s made for some hefty gains for
those who bought and held over the course of the next twenty years or
more.
Investment
Diversification
It is true that the greater the risk, the
greater the potential rewards in investing, but taking on unnecessary risk
is often avoidable. Investors best protect themselves against risk by
spreading their money among various investments, hoping that if one
investment loses money, the other investments will more than make up for
those losses. This strategy, called diversification, can be neatly
summed up as, "Don't put all your eggs in one basket." Investors also
protect themselves from the risk of investing all their money at the wrong
time (think 1929) by following a consistent pattern of adding new money to
their investments over long periods of time.
Once you've saved money for investing, consider carefully all your options
and think about what diversification strategy makes sense for you. While
the SEC cannot recommend any particular investment product, you should
know that a vast array of investment products exists-including stocks and
stock mutual funds, corporate and municipal bonds, bond mutual funds,
certificates of deposit, money market funds, and U.S. Treasury securities.
Diversification can't guarantee that your investments won't suffer if the
market drops. But it can improve the chances that you won't lose money, or
that if you do, it won't be as much as if you weren't diversified.
Investment Risk Tolerance
What are the best saving and investing
products for you? The answer depends on when you will need the money, your
goals, and if you will be able to sleep at night if you purchase a risky
investment where you could lose your principal.
For instance, if you are saving for retirement, and you have 35 years
before you retire, you may want to consider riskier investment products,
knowing that if you stick to only the "savings" products or to less risky
investment products, your money will grow too slowly-or given inflation or
taxes, you may lose the purchasing power of your money. A frequent mistake
people make is putting money they will not need for a very long time in
investments that pay a low amount of interest.
On the other hand, if you are saving for a short-term goal, five years or
less, you don't want to choose risky investments, because when it's time
to sell, you may have to take a loss. Since investments often move up and
down in value rapidly, you want to make sure that you can wait and sell at
the best possible time. |